Deliverable Forward

A deliverable forward is a forward contract in foreign exchange where, on the settlement date, the two parties actually deliver the currencies to each other: one pays the agreed amount of the first currency and the other pays the agreed amount of the second, at the exchange rate fixed when the deal was struck. It is the standard form of FX forward contract for freely traded currencies such as the US dollar, euro, yen and pound, and one of the most common tools for hedging currency risk.

The term is used mainly to distinguish it from a non-deliverable forward (NDF), which settles only the difference between the agreed rate and the market rate in a convertible currency, usually US dollars. Deliverable forwards are possible when a currency can be freely bought, sold and moved offshore; where capital controls restrict this, markets tend to use NDFs instead.

A UK importer that must pay a US supplier 1,000,000 US dollars in three months can agree a deliverable forward with its bank today. If the agreed forward rate is 1.2650 dollars per pound, the importer knows it will pay $1{,}000{,}000 \div 1.2650 \approx 790{,}514$ pounds on the settlement date. On that date it pays the pounds to the bank and receives the dollars, which it then sends to the supplier. Whatever happens to the spot rate in the meantime, the cost in pounds is fixed.

Deliverable forwards are usually traded over the counter between a customer and a bank or FX dealer, rather than on an exchange. Terms such as amount, date and rate can be tailored to the customer's needs. Some providers offer window forwards, which allow delivery at any time within a set period.

The forward rate is not a forecast of the future spot rate. It is derived from the spot rate and the interest rates of the two currencies, a relationship known as covered interest rate parity:

• $F$ is the forward rate and $S$ the spot rate, both quoted as units of the quote currency per unit of the base currency.
• $i_q$ and $i_b$ are the annual interest rates of the quote and base currencies.
• $d$ is the number of days to settlement (some currencies use a 365-day basis).

If the spot rate is 1.1000 US dollars per euro, the dollar rate is 5% and the euro rate is 3%, then for 90 days $F = 1.1000 \times (1 + 0.05 \times 0.25) \div (1 + 0.03 \times 0.25) = 1.1000 \times 1.0125 \div 1.0075 \approx 1.1055$. The difference between forward and spot, expressed in pips, is the forward points. Banks add a margin to this rate for customers, in the same way as the FX spread on spot deals.

• Hedging trade flows. Importers and exporters fix the home-currency value of future payments and receipts, managing currency exposure.
• Treasury planning. Companies lock in rates for dividends, intercompany loans or capital spending in foreign currencies.
• Investment hedging. Fund managers hedge foreign assets back to their base currency, often rolling forwards each month or quarter.
• Payments businesses. Remittance and payment firms use forwards to cover predictable future payouts.

A deliverable forward removes exchange rate uncertainty but creates other risks. The contract is binding, so if the underlying payment is cancelled or delayed, the company must still deliver the currency or close the contract, possibly at a loss. If the spot rate moves in the company's favour, it cannot benefit. Each party also takes counterparty credit risk on the other until settlement, which is why banks set credit lines and may require margin or collateral. At settlement there is settlement risk if one side pays and the other does not, which payment-versus-payment arrangements such as CLS reduce for eligible currencies.

Under international accounting standards, forwards are derivatives measured at fair value, and companies may apply hedge accounting to match gains and losses with the hedged item. In some jurisdictions, physically settled FX forwards entered into for commercial purposes are treated differently from speculative derivatives for regulatory reporting and conduct rules, so firms selling forwards to businesses need to check whether they are providing a regulated investment service.